Question

Tracero Inc. is a new automobile manufacturer that specializes in electric cars for export to Italy, Switzerland, and England. The company anticipates that its sales for the next six months will follow that which is given in the table below: Country Quantity Price Revenue Spot Rate 6-Month Forward Rate Italy 3,920 € 41,730 €163,581,600 $1.2307/1€ $1.2485/1€ Switzerland 675 549,094 F33,138,450 $1.0485/1F $1.0685/15 England 535 €43,132 €23,075,620 $1.3840/10 $1.3962/1€ Tracero's supply chain is globally based for which its total cost structure is shown by the following table: Country Switzerland China Russia Mexico ($) France Germany Finland Italy Cost F66,151,533 ¥27,645,290 €17,012,486 MP19,139,047 €29,771,851 €40,404,655 €10,632,804 €31,898,412 Spot Rate $1.0488/17 ¥6.3346/15 P56.6589/15 MP18.5887/1$ $1.2307/1€ $1.2307/1€ $1.2307/1€ $1.2307/1€ 6-Month Forward Rate $1.0685/1F ¥6,4020/1$ P57.7081/1$ MP19.1780/15 $1.2485/1€ $1.2485/1€ $1.2485/1€ $1.2485/1€ 1) Detail the Forward Contract hedging strategy for Tracero. 2) Given the following data, detail the hedging strategy using Futures Contracts Contract: September 2018 Euro Futures Contract @ $1.2496 Size of Contract: 125,000 Euros 3) Given the following data, detail the hedging strategy using Options Contracts Contract: Euro September $1.25 Puts @ $.0255/Euro Size: 125,000 Euros 4) If the cost of capital is 11.5675%, what is the cost to Tracero of the option strategy? 5) What is the break-even spot rate between the forward and option strategies? 6) Give a description of when the use of options may be favored for Tracero as opposed to a forward contract strategy. In addition, give the downside to the use of options.

Answer 1

Answer for Part 1

Total Cost of Production

We have costs in multiple currencies and sales in multiple currencies. The strategy that can be used is we may naturally hedge some currencies. i.e. Setoff Inflow(Sales) of $ currency with outflow(Costs) of $ currency. Then we hedge the remaining portion.

We calculate total costs currency wise:

Total Costs	Amount	Currency
Switzerland	66151533	F
China	27645190	Y
Russia	17012486	P
Mexico	19139047	MP
France	29771851	E
Germany	40404655	E
Finland	10632804	E
Italy	31898412	E

Total Costs Currency wise
F	66151533
Y	27645190
P	17012486
MP	19139047
E	112707722

Total Revenue Currency wise:

Total Revenue	Amount	Currency
Italy	163581600	E
Switzerland	33138450	F
England	23075620	Pounds

So Currency E can be set off i.e.Inflows of E Currency can be naturally set off against the Outflow of E Currency and remaining E Currency may be set off using various hedging instruments.

Currency	Inflow	Outflow	Naturally Hedged	To be hedged
	a	b	(Min of a or b)
F	3,31,38,450.00	6,61,51,533.00	3,31,38,450.00	-3,30,13,083.00
Y	-	2,76,45,190.00	-	-2,76,45,190.00
P	-	1,70,12,486.00	-	-1,70,12,486.00
MP	-	1,91,39,047.00	-	-1,91,39,047.00
E	16,35,81,600.00	11,27,07,722.00	11,27,07,722.00	5,08,73,878.00
Pounds	2,30,75,620.00	-	-	2,30,75,620.00